In the much-anticipated Hamel decision, the Texas Supreme Court finally addressed the definition of a “fully adversarial trial” under the Gandy rule, holding that a reviewing court must focus on the insured’s incentives to contest liability, rather than on retroactive evaluation of tactical trial details.   Great American Ins. Co., et al v. Hamel, — S.W.3d –, No. 14-1007, 2017 WL 2623067  (Tex. June 16, 2017) (citing State Farm Fire & Casualty Co. v. Gandy, 925 S.W.2d 696, 714 (Tex. 1996)). The decision settles some controversies over Gandy, but raises several important questions insurers should be aware of.

         Background

The Hamels sued their builder, TMB, for defective construction of their home. Great American, TMB’s liability insurer, denied defense for reasons it later conceded were inadequate.  Before trial, Hamel essentially agreed not to execute any judgment against TMB’s assets. Before the bench trial, TMB provided factual stipulations supporting duty, breach and damages, and testified consistent with them at trial.  The Hamels offered supporting evidence, but TMB called no witnesses, made no objections to the Hamels’ evidence, and did not submit proposed findings.  Based on the Hamels’ uncontested findings, which largely tracked the builder’s pre-trial stipulations, the trial court awarded the Hamels damages for repair costs, loss of market value, and mental anguish.

The Hamels then sued Great American to recover the underlying damages. The Hamels abandoned extra-contractual claims and went to a bench trial on breach of contract. The underlying record and the stipulations, among other evidence, were admitted at trial and the court entered judgment for the Hamels finding TMB’s negligence caused the damage and, on the primary issue presented, that the rule of Gandy did not preclude enforcement of the underlying judgment against TMB.  See 2017 WL 2623067, at *4 (citing Gandy, 925 S.W.2d at 714).  That rule prohibits an insured’s judgment creditor from enforcing a judgment against the insurer if rendered without a “fully adversarial trial.” Id. The trial court found the Hamels’ trial strategies and actions were reasonable and were not collusive or fraudulent and that the underlying trial “was . . . an adversarial proceeding.” Id.  The El Paso Court of Appeals affirmed, holding the underlying judgment was the result of a fully adversarial trial, and TMB’s assignment of its claims against Great American to the Hamels was valid. Id. (citing Great Am. Ins. Co. v. Hamel, 444 S.W.3d 780 (Tex. App.—El Paso 2014)).

            Decision

On appeal the Supreme Court explored Gandy’s two-pronged conclusion. Gandy first held an insured’s assignment of its rights under a liability policy to an injured party is void if:

(1) it is made prior to an adjudication of plaintiff’s claim against defendant in a fully adversarial trial, (2) defendant’s insurer has tendered a defense, and (3) either (a) defendant’s insurer has accepted coverage, or (b) defendant’s insurer has made a good faith effort to adjudicate coverage issues prior to the adjudication of plaintiff’s claim.

Gandy, 925 S.W.2d at 714. The Gandy Court independently concluded: “In no event . . . is a judgment for plaintiff against defendant, rendered without a fully adversarial trial, binding on defendant’s insurer or admissible as evidence of damages in an action against defendant’s insurer by plaintiff as defendant’s assignee.” Id.

Hamel explored in detail only the second prong because Great American had conceded the validity of TMB’s assignment to the Hamels.  To “provide further clarity on this issue”, the Court nevertheless held the assignment was valid because: a) TMB assigned its claims following, not preceding, a trial and judgment; b) unlike the insurer in Gandy, Great American breached its duty to defend; and c) Great American neither accepted coverage nor made a good-faith effort to adjudicate coverage before the Hamels’ claims against TMB were resolved.  2017 WL 2623067, at *6.

That holding did not settle the case, however, because Great American argued, independent of the assignment’s validity and despite its failure to defend, that Gandy precluded enforcement of the judgment against Great American solely because it was “rendered without a fully adversarial trial.” Id.  In the older Block decision, the Supreme Court had indicated an “insurer’s breach of its duty to defend necessarily renders any covered judgment binding on the breaching insurer.”  2017 WL 2623067, at *6 (citing Employers Cas. Co. v. Block, 744 S.W.2d 940, 942-43 (Tex. 1988)).  In the Atofina decision, subsequent to Gandy, the court applied Block where an insurer breached its duty to defend avoiding Gandy’s “fully adversarial trial” rule because “Gandy’s key factual predicate [was] missing” in that the insured had not assigned its claims but had sued the insurer directly.  Id. (citing Evanston Ins. Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660, 673 (Tex. 2008)).  The Hamel Court noted that Gandy’s “fully adversarial trial” rule had shifted focus away from failure to defend and “toward whether the underlying judgment accurately reflects the plaintiff’s damages and thus the insured’s covered loss.”  Id.

This raised the question of what a “fully adversarial trial” must entail.  The Court rejected the Court of Appeals’ approach – retroactively evaluating and second-guessing trial tactics – and concluded “determining whether and when [judgment] calls [made by trial lawyers] destroy the ‘adversarial’ nature of the proceeding is simply not possible”. 2017 WL 2623067, at *7.  The Court announced its new rule:

Today we clarify that the controlling factor is whether, at the time of the underlying trial or settlement, the insured bore an actual risk of liability for the damages awarded or agreed upon, or had some other meaningful incentive to ensure that the judgment or settlement accurately reflects the plaintiff’s damages and thus the defendant–insured’s covered liability loss.

Id. Applying that standard, the Court held the underlying trial in that case was not fully adversarial because “the parties’ pretrial agreement [not to levy any judgment against TMB’s assets] eliminated any meaningful incentive [TMB] had to contest the judgment” by “remov[ing] any financial stake [TMB] had in the outcome,” leaving liability insurance as the only potential source of satisfying any judgment.  Id. at *8. That absence of incentive to defend rendered the underlying suit “a mere formality.” Id. 

  Questions Raised

This question of incentives to win raises interesting issues that may be litigated as insureds and tortfeasors scramble in the wake of Hamel to find ways to cooperate in insurer set-ups.  For example, Hamel cited, as evidence of a lack of incentive, the builder’s testimony that he did not care about certain credit issues after the pretrial agreement was executed because his assets were not at risk.  Id. at *8-9.  Is “incentive” thus an objective question of the actual risks to the insured’s assets or can it be proven by subjective notions the insured has about his risks? Hamel does not say, but, as if to emphasize the quandary, the Court noted a formal, written pretrial agreement is neither necessary nor sufficient to disprove adversarial trial, but that the presence of such an agreement set up a presumption of lack of adverseness, and vice versa.  Id. at *9. The court left open the quantum and nature of proof necessary to overcome whatever presumption is present. Id. at *9, n. 9.

Hamel is an insurer-friendly decision because it gives insurers who decline to defend a means of avoiding liability, even as it requires the policyholder who is deprived of a defense to prove its assets are actually at risk in the liability phase, even if no collusion with the tortfeasor can be shown.  This fact is mitigated by the secondary holding in Hamel that the coverage case can cure defects in adverseness.  Id. at *10-11.  Noting “relitigation” of liability and damages, while not a “perfect solution” is “necessitated by the circumstances”, the Court concluded that under its approach “the insurer will have the opportunity to challenge its insured’s underlying liability and the resulting damages, the abandoned insured is protected, and the burden on the plaintiff is fair. And of course, the insurer has every incentive to assert a strong defense during the Insurance Trial.”  Id. at *10.  Applying this standard to the facts of the case before it, the Court held the parties did not effectively retry the underlying damages case and did not “cure” the problems raised.  It remanded for a new trial.  Keep an eye on this space for further developments!